Over the past month the market has come full circle from essentially ruling out any further ECB action to almost expecting some purchases of assets (both accompanied by the respective strengthening and then weakening of the euro exchange rate).

This was topped off today with the latest inflation data which showed that inflation in the eurozone has dropped to its lowest level for five years (annual rate of 0.5%).

A couple of points to note on this data:

While energy prices are still the largest driver of the contraction, unlike some previous months, core inflation (without energy, food prices or tobacco) has also fallen. This may encourage the view that the decreases are not simply due to short term shifts in commodity prices.

That said, the core inflation rates remain above where they were in November 2013 when the ECB previously cut rates.

Other national inflation data has been quite weak – Spain moved into outright deflation in March, while German inflation was running at only 1%.

As Gavyn Davies noted on twitter, the 0.5% rate falls outside of the ECB’s March projections for inflation this year and up to 2016. This raises questions about whether the inflation rate is still on the upward path forecast. Combine this will the volatility and tendency to strengthen of the euro and the ECB’s projections do not seem to be holding up too well.

The other aspect adding weight to expectations has been dovish comments by ECB members, notably by Bundesbank President Jens Weidmann. Many believe this has “opened the door” to significant action by the ECB. Open Europe’s Raoul Ruparel addressed this issue on his Forbes blog on Friday arguing:

“The real issue from a German perspective is not necessarily that the door was ever firmly closed (or open) but that we remain someway from the QE door and to get there would require carefully negotiating some politically and legally explosive obstacles.”

He concludes:

“In the end, I think we find ourselves in a fairly similar position to last month (albeit having gone through a cycle of over scepticism and now over optimism) – further action remains possible but not yet highly likely.”

This meeting will be another one to watch but so far the ECB seems strongly wedded to its new communication and forward guidance policy, which it believes can allow greater control over rates markets, it is not yet clear whether it is willing to abandon this approach or push it over the barrier into full on policy action.

If you want to get a sense of how badly the latest French local elections went for President François Hollande, have a look at today's front page of left-leaning French daily Libération:

The headline means 'The punishment', and it summarises the outcome of the local vote pretty well. According to data from the French Interior Ministry, the centre-right (that is, the opposition UMP and its allies) gained 139 towns with more than 10,000 inhabitants compared to the 2008 local elections. The centre-left (Hollande's Socialist Party and its allies) lost 160. The fact that the Socialist Party managed to retain Paris - where Anne Hidalgo was elected as the city's first female mayor - cannot compensate for what was an unequivocal defeat nationwide.

Marine Le Pen's anti-EU Front National took control of eleven towns - in addition to Hénin-Beaumont, where the party won an outright victory in the first round. Though not impressive in absolute terms (see this blog post from last week for some more background information), the score is nonetheless politically significant. It shows how French voters increasingly see Front National not just as a mere 'protest party', but as a credible alternative for power - albeit so far only at the local level and in a very limited number of towns.

Meanwhile, the immediate consequence of yesterday's local election fiasco is that Hollande is expected to announce a cabinet reshuffle any moment. The French President has just come out of a two-hour meeting with Prime Minister Jean-Marc Ayrault, whose departure looks very likely, judging by the headlines in the French press over the past few days.

Interior Minister Manuel Valls, who enjoys a pretty high approval rating compared to his fellow cabinet members (in part thanks to his tough stance on certain crime and migration issues), is broadly seen as the favourite to replace Ayrault as Prime Minister. Laurent Fabius, currently serving as Foreign Minister, is another name being mentioned by the French media.

However, in light of the latest macroeconomic indicators, the impression remains that moving a few ministers around will not be enough to restore the French government's credibility vis-à-vis the electorate - unless the policies also change and France makes some real progress in pushing ahead with the reforms needed to restore its competitiveness within the eurozone.

Friday, March 28, 2014

In a major coup for David Cameron, Chancellor George Osborne has penned a joint op-ed in the FTwith his German opposite number Wolfgang Schäuble. Both argue for the need for EU reform (including services liberalisation) and for safeguards for non-eurozone states in the face of further eurozone integration - all areas of potential consensus we flagged up in our recent 'Anglo-German bargain' briefing.

On the acceptance of the different needs of non-euro and euro members, and therefore the need for safeguards, they say:

“As the euro area continues to integrate, it is important that countries outside the euro area are not at a systematic disadvantage in the EU. So future EU reform and treaty change must include reform of the governance framework to put euro area integration on a sound legal basis, and guarantee fairness for those EU countries inside the single market but outside the single currency.”

Getting explicit German support for this view and providing a united front on this issue is an important step forward for the UK and for Cameron's EU reform agenda. While Germany has previously hinted at willingness to support the UK on this issue, this is certainly a step up. It also brings Cameron closer to ticking off one of the key targets he recently put forward in what was probably the most important article nobody spotted. Open Europe has long argued that safeguards against further eurozone integration are crucial and that they will play a key role in determining the new set up and balance of the EU.

That being said, the UK government should not be complacent about where it now stands in terms of its reform agenda. While this represents progress, there is some way to go. This provides an important opportunity and a good base for the UK to begin testing specific reform proposals on other EU governments and electorates. After all, while Germany is the largest and possibly the most important partner to get on board, the UK also needs to convince the rest of the EU. While teaming up with Germany should broadly help on this front there is one constraint - not everyone buys into Germany's vision of the new eurozone with significant central oversight and limited share of liabilities. However, as the banking union shows, Germany has so far been adept at influencing the construction of new eurozone structures in its own image.

Possibly a more surprising inclusion is the joint support for services liberalisation, of which they say:

“We must complete the EU’s single market, especially in
services, open up to international markets and conclude reforms to the euro
area.”

Again, we've been advocating this for some time - we estimate that it could be worth up to €294bn for the EU's economy. Traditionally, Germany has been one of the staunchest obstacles to such service liberalisation, due to its many protected professions. As such gaining its public support is another big coup for Cameron and a positive step for the EU economy.

One final interesting point is noted by the FT:

"Mr Schäuble told Bruges’s College of Europe on Thursday that he wanted negotiations on a revised treaty to start straight after the European Parliament elections in May."

This is equally as important as all of the above for Cameron given that some of the biggest doubts around his push for EU reform and referendum have been on the time-frame of the negotiations. There is clear hope that discussions around treaty changes will begin in earnest after the elections (although in an ideal world they would have been part of an open and transparent debate within the elections).

Overall the approach isn't perfect - it still speaks of a two-speed Europe, suggesting all member states are heading in the same direction, which is not the case - but it is a big step and an important one for Cameron. It is now vital that he seizes this opportunity to push a wider EU reform agenda.

Thursday, March 27, 2014

The German government's preliminary report on EU migration was presented yesterday by Interior Minister Thomas de Maizière and Labour Minister Andrea Nahles, and contains some very interesting measures.

The explosive combination of EU migration and access to benefits has been giving David Cameron a headache for a while now, although as we’ve noted in our press summary and on our blog, similar debates have also been kicking off in Germany, Denmark, the Netherlands and elsewhere. In particular in Germany it has been rumbling for some time, with some mention of it during the election and the new coalition agreement, however this intervention is likely to step up the debate a notch or two.

The proposals actually have quite a lot in common with Cameron's position, although not exactly and each side goes further on certain specific issues. The key question remains though whether they will be judged to be consistent with EU law. This remains unclear and whether or not a challenge from the ECJ is forthcoming will certainly set a precedent in this area.

Key proposals

Potentially the most important proposal in the draft report is that:

Jobless EU migrants seeking work in Germany, who have no means of supporting themselves and have limited job opportunities, should be given a limited window to find a job before being required to leave.

Crucially, the report stresses that this can be achieved within the constraints of existing EU law as this would not apply to those EU jobseekers who have a 'reasonable' chance of being employed, those with sufficient financial means including affording their own health insurance, or even those who have a “mini-job” involving just a few hours of work per week.

The report recommends that EU migrants who cannot fulfil these requirements would have a grace period before being expelled, and notes that the ECJ deems six months to be appropriate. However, whether such expulsions would work is not clear, since, in theory, EU migrants’ right to free movement would kick in immediately after they left Germany, allowing them to return right away again.

Other proposals in the paper include:

Temporary re-entry bans on migrants abusing EU free movement (by forging documents or being in a fake marriage, for example).

Linking child benefit payments to tax identification numbers.

€200m in financial assistance to help local authorities to deal with migration (€140m would come out of the European Social Fund).

How does this compare to Cameron's position?

There are some similarities between the German position as set out yesterday and Cameron's position as set out in his FT piece last year, but also some important differences.

On the question of kicking EU migrants out, Berlin is proposing to do so in cases where migrants do not have a job after six months, have no realistic prospects of finding one and are not financially self sufficient, while Cameron wrote that:

“If people are not here to work – if they are begging or sleeping rough – they will be removed. They will then be barred from re-entry for 12 months, unless they can prove they have a proper reason to be here, such as a job.”

This means that Cameron and Merkel have adopted a similar position on removing people who are not working, but London is going further on the specific question of the re-entry ban which would apply to everyone in that position, whereas the German re-entry ban would be limited to more serious cases such as fraud.

On the question of child benefit, the German and UK positions differ. In the UK, Cameron, Clegg and Miliband all want to be able to stop paying child benefit to parents whose children do not live in the UK. The German position is different – the government currently has no plans to restrict child benefit for children not resident in Germany, the linking of the payments to tax ID numbers is designed to crack down on potential fraud and duplicate payments.

Next steps
The preliminary report will be finalised by end of June before it enters the legislative process. How will the EU respond? The big question mark is if - despite what the report says - these proposals are compatible with EU law or if either the six-month cut off, or the re-entry ban could face a legal challenge.

Interestingly the report also has a section on “possible further measures on the European level” which notes that:

“Also in other [EU] member states…the issue is debated, in parts very controversially. In this respect the question arises….if and in how far considerations for further steps on the European level or together with European regulations are necessary and reasonable. The Committee will deliver an opinion on this in its final report.”

Meanwhile, there are two separate cases referred from German social courts to the ECJ to watch out for. They deal predominantly with the questions in how far EU jobseekers and EU migrants which are “economically inactive” can be generally excluded from receiving unemployment benefits in Germany. We will closely monitor the developments and keep you updated.

The first EU debate between Nick Clegg and Nigel Farage on LBC was for the most part restrained with a surprising amount of detail and substance. Most of the key fault lines in the UK-EU relationship were touched on.

However, given that the two men represent the polarising ends of the debate, there were also a number of claims that struggled in the accuracy department. Here is our quick 'fact-check' of the key debating points:

On the referendum question, Clegg said that when it came to new EU Treaties transferring new powers to Brussels,

"I've never wavered in that position, that's why the last time the rules changed, something called the Lisbon Treaty, I said there should be a referendum."

It is true that the Liberal Democrats called for referendum on Lisbon but crucially it was an in/out referendum which was not on the agenda at the time - the issue wasn't even put to put to a vote. There was however a vote on whether to have a referendum on the Lisbon Treaty itself on which the party abstained, despite the fact that together Tory MPs, Lib Dem MPs and Labour rebels could have passed it. Clegg is being highly disingenuous by blurring the distinction between an in/out referendum and a treaty specific one. Farage's quip that there was no point waiting for a new Treaty as powers were being transferred to the EU every week via directives and ECJ rulings was quite effective in this context.

Claim - Farage: Under EU rules we have a completely open door to 485 million Europeans Verdict - Partially true but unclear on the numbers

It is true that the free movement of labour is a fundamental principle of the EU and the UK cannot limit the numbers of EU migrants coming over. However, Clegg was right to point out that the right to free movement is not completely unqualified - under the free movement directive migrants have to be able to support themselves financially or have 'reasonable' prospects of finding a job.

In terms of Farage's 485 million figure though we have to say we are a bit confused as to where exactly this comes from - the population of the EU28 is around 506 million, which minus the UK's approximately 63 million leaves 443 million.

Claim - Clegg: 3 million jobs would be at risk if UK left the EUVerdict - Highly unlikely - would depend on a range of other factors

Clegg cited the well-worn '3 million jobs linked to the EU figure' despite established doubts over its veracity. Recently those tending to cite this number have replaced "depend on" with "linked to" but it's still dubious. As we've argued in the past, this claim is one of the most conspicuous examples of a rogue statistic without any credible counter-factual attached to it. The assumptions behind the 3 million jobs figure is that there would be no trade at all trade with Europe if the UK left the EU, which of course is nonsense - a similarly heroic assumption to that which Better Off Outers make when calculating the cost of EU membership based on all regulatory cost magically disappearing on Day 2 post-Brexit.

Claim - Farage: UK would hold the whip hand in negotiations over a new trade deal with the EUVerdict - Very uncertain

Farage argued that in the event of an exit, the UK would "hold the whip hand" in trade negotiations with the EU due to the EU's trade deficit with the UK. We've looked at this in detail - the key point is that while this is true in the area of goods, when it comes to services - a crucial and thriving area of the UK economy - this is not the case. So with that logic, EU countries would have incentive to strike a deal with the UK in goods but not services including financial services. Secondly, the process for leaving the EU - the so-called Article 50 - actually involves less control for the UK than is often assumed, including a Qualified Majority Vote on the final deal in which the UK will not take part.

Claim - Farage: 75% of UK laws come from the EU. Clegg: no it's 7%Verdict - Both are wrong

The contentious topic of how exactly how many UK laws are derived from the EU also came up, with Farage gleefully citing Viviane Reding's absurd claim that 75% of UK laws are decided in Brussels (as we've argued many times, Reding must secretly be on the UKIP payroll). Clegg went with the House of Commons' Library's briefing which estimated this to be around 7%. Regular readers will know we've analysed this in painful detail and the truth is it is simply not possible to say exactly - what's clear is that it's neither 7% (this only counts primary legislation which isn't meaningful at all) nor 75%. (But basically too many).

Farage is correct that the UK's contribution to the EU works out as around £55 million per day. However, that it is a gross figure which does not include the UK rebate (cold, hard cash the UK gets back from Brussels every year) and nor the UK's receipts from the EU budget (even if this is only UK taxpayers' cash being re-routed via Brussels).

Claim - Clegg: Without the EAW we'd struggle to extradite criminals and terroristsVerdict - The EAW makes the process faster but it is not indispensable

The European Arrest Warrant (EAW) is used by EU states to speed up extradition procedures. It is true that the EAW has been used by the UK to recover suspected terrorists and other criminals from other EU states who have subsequently been found guilty and locked up. It is however untrue to claim that suspects such Hussain Osman and Jeremy Forrest could not have been recovered without it. Also before the EAW was agreed, there were agreement on extradition and the UK managed to successfully extradite plenty of criminals from EU countries through bilateral procedures. These were considerably slower but it is highly unlikely that with or without the EAW Italy would have wanted to hang on to Hussain Osman or France to Jeremy Forrest.

The much hyped debate between UKIP leader Nigel Farage and Lib Dem leader Nick Clegg has made the Westminister village buzz.

So who won? The headlines give it to Farage on the basis of the instant YouGov poll commissioned by the Sun which found that 57% believed Farage had “performed better overall” in the debate, 36% believed that Clegg had won (7% said they didn't know).

A decisive victory then? Well LBC's twitter 'worm' had Farage only just edging it, and there was a general consensus among the Westminster village punditry that Clegg had emerged as the winner.

However, the poll also found that after the debate 47% believed Britain should stay in the EU – down from 48% before – while 44% wanted to leave – up from 42% before the debate. This means that even a substantial number of those who want to stay in the EU believed Farage had performed better than Clegg which has to be a worry for the 'in at all costs camp'. Moreover, the poll also found that following the debate, the number of people who believed leaving would be “good for jobs in Britain” rose from 28% to 34%.

Finally, the big omission from the debate was any substantial discussion of EU reform which we've argued will be key to swinging public opinion in favour of staying in. Will the post debate polling lead Team Clegg to focus more heavily on this in Round II on the BBC next week? Let's hope so.

Like all political obsessives up and down the country I’ve stocked up on popcorn ahead of Nick Clegg and Nigel Farage’s upcoming duels over Europe in anticipation of some captivating political theatre. However, from my more sober perspective as a political analyst, such a binary, ‘all-or-nothing’ debate over Europe is fundamentally flawed as it does not speak to where the majority of the British public are at. Polls have consistently shown that when respondents are offered options beyond staying in on the current terms or leaving altogether, the option of staying in a reformed/slimmed down EU proves the most popular across the political spectrum.

People hold different views about how they would like to see the European Union develop. Which of these statements comes closest to your view? (click to enlarge)

Source: YouGov poll for Open Europe, February 2014

As the polling demonstrates, the public is split over the question of the UK’s future in Europe, although staying in a less integrated Europe is by far the single most popular option across the political spectrum, including among Lib Dem voters (more so than among Labour voters!) and even among a substantial chunk of UKIP voters. The concern is that the debates will focus on whether the UK ought to leave or stay in at any cost, thereby ignoring the wider debate about how best to achieve EU reform.

David Cameron’s EU policy may suffer from a number of shortcomings but to his credit, he is at least trying to achieve the reforms that a majority of the public want. Nick Clegg has also acknowledged that the EU needs reform on a number of occasions and he recently set out a “bold” three-pronged agenda based on further trade liberalisation within the single market as well as between the EU and the rest of the world, slimmed down EU institutions and less regulation, and greater democratic accountability via an increased role for national parliaments. This is welcome, even if it falls short of the more ambitious and comprehensive vision for EU reform – with powers flowing back to member states – that he set out back when he was an MEP.

However, at the same event, he undermined his own message by claiming that the most that Cameron’s reform strategy could achieve – which includes all the objectives set out by Clegg himself – as “a few crumbs from the top European table… a little tweak here and there”. This is hugely unhelpful as it plays into the narrative that the UK has virtually no influence over the direction and development of the EU and must take what it is given.

Moreover, there are large gaps in Clegg’s argument when it comes to the future of UK-EU relations. How would the Lib Dems react if the UK were to lose an EU legal case over the safeguards it applies to prevent potential abuse of the UK welfare system by EU migrants? The party supports the so-called ‘right to reside test’ so would they accept its axing at the behest of the European Commission and Court of Justice? Likewise, the party supports safeguards to prevent the rules of the EU’s single market from being set by the Eurozone bloc to the detriment of non-euro member states. Would Lib Dems still insist on staying in if in the longer term the EU became an extension of the Eurozone?

This all matters because in the event of the Coalition being extended post-2015, the two parties will have to hammer out a common position on EU reform/renegotiation prior to a 2017 referendum which Cameron has made clear is an absolute red line for him. Hopefully, Clegg will use the debates to flesh out his ideas for EU reform in greater detail instead of repeating discredited claims about 3 million jobs being lost in the event of an exit. Ultimately, with the public more or less split down the middle on the in/out question, reform is not only not only worth pursuing as an end in itself, but also as a means of securing an ‘in’ vote when the referendum eventually comes.

Tuesday, March 25, 2014

When the anti-euro Alternative für Deutschland was first founded, it was derided as a fringe party for professors obsessed with ordoliberalism that would struggle to make a lasting impact on the German political scene.

However, the party got within 0.3% of the vote of winning seats in the Bundestag in September and is polling at around 6%-7% ahead of the European elections, meaning it looks certain to win seats in Brussels/Strasbourg. Yet the party's relatively strong showing in the polls masks serious internal divides along personnel and policy lines.

At the start of the year, it was being reported that some founding members were leaving in disillusionment in the belief that the party was abandoning its liberal roots and embarking on a sharply 'rightward' trajectory, which was manifested by the embracing of traditional Christian moral values and taking a tough line on immigration - AfD were notably the only mainstream German party to praise the results of the Swiss referendum on curbing free movement.

Initially, it seemed that this shift to the 'right' was limited to social policy, with AfD still maintaining its liberalism on economic policy; Hans-Olaf Henkel - the former head of the Federation of German Industries - described it as "Germany's last liberal party". However, this also seems to have been consigned to the past following the party's convention over the weekend at which it voted on its manifesto for the European elections.

Crucially, the party's grassroots voted to reject the EU-US free trade deal (TTIP) currently under negotiation despite strong support from the leadership including party leader Bernd Lucke, who argued that it was a "positive, constructive objective which is very much in Germany's interest". Beatrix von Storch (pictured), an MEP candidate and high profile AfD activist - who for many epitomises the party's recent lurch towards conservatism - argued that the agreement "is not fair and will burden our country".

Interestingly, when it came to the recent events in the Crimea, the party's deputy federal spokesperson criticised the independence referendum but also called for greater "understanding" for Moscow and described the interim Ukrainian government as "not democratically legitimate". A motion was passed (to thundering applause according to FAZ) rejecting German taxpayer assistance for Ukraine and economic sanctions on Russia.

Such sentiments - scepticism of free trade deals (or 'directed trade' as libertarians would say) and emphasises on isolationism in world affairs, puts the AfD closer to either the American "Old Right" (which Europeans tend not to even remotely understand) or the European Socialist Left.

So what does all this mean? Well it seems that AfD are at risk of becoming a catch-all populist party with strongly ideologically contradictory factions rather than one which can be easily placed on the traditional 'left/right' axis. This applies to a number of other European parties which combine elements of both including the National Front, PVV, the (True) Finns party and UKIP (although UKIP economic policy is more liberal than the others'). It also shows that those Tories keen for AfD to join the ECR group in the European Parliament may wish to pause for thought.

To some extent this is not surprising given that even in its early stages the party paradoxically drew disproportionate support from former FDP and Die Linke voters. We also noted after the elections that the party had done particularly well in Eastern Germany, which tends to vote more heavily for left-wing parties than West Germany. In the East, AfD has also struggled to contain creeping take-over attempts by more nationalist elements.

The question for the party is where does it go from here: does it establish itself as a permanent protest party borrowing ideas and policies from the political smorgasbord as it sees fit - there is clearly a gap in the market - or does it try to remain a genuine economically liberal party angling for a spot in the mainstream?

Monday, March 24, 2014

Now that Russia has full military control over Crimea the the implications of taking control are beginning to sink in with President Medvedev claiming that "it's now our headache". The most obvious headaches are electricity and water. Medvedev directly raised this issue saying:

"This question, of course needs to be addressed through international negotiations, but we will need to chose the best way to supply the peninsular."

An interesting development given Russia's reluctance to engage with Ukraine to date. The water situation in particular should concern Moscow as Ukraine supplies most of Crimea's water, something the above map of the Soviet era North Crimea Canal makes quite clear. So just as Hong Kong's dependence on China reduced the UK's room for manoeuvre, Crimea can not survive without Ukraine.

So what will Russia do? Short of annexing yet more territory to secure the canal - which would surely trigger further sanctions - not to mention a military confrontation with Ukraine - and push them into full economic isolation, logically they must at some point come to the table. Ukraine is unlikely to immediately cut off the water and cause real hardship for the inhabitants, who are still Ukrainian citizens, but nor is Ukraine a charity. In the longer term Russia could try to construct alternative conduits but that would be complex, expensive, and time consuming so some agreement with Kiev will need to be reached.

Obviously expecting to strike a deal with Ukraine so shortly after annexing its territory is unrealistic. But there are numerous other issues that Russia will need to discuss, the transshipment of gas to the EU, Ukraine's outstanding debts to Russia, and other border issues. Russia could perhaps seek to give ground in other areas.

So will Russia change its tune and come to the table? Logic would dictate it has two choices, go further and secure the Crimean hinterland, including the North Crimea Canal or seek a deal with Ukraine. Hopefully it will be the latter...

Yesterday was a big night for Marine Le Pen's anti-EU Front National, which emerged as the main winner of the first round of the French mayoral elections. The party won an outright victory in Hénin-Beaumont, a
former mining city in northern France, and finished ahead in six other towns - where its score ranged from 27.69% (in Digne-les-Bains) to 40.3% (in Fréjus).

We will have to wait until tomorrow evening for the final results. But, according to the preliminary figures made public by French Interior Minister Manuel Valls, the centre-right (that is, the UMP and its allies)
won 46.54% of votes nationwide - well ahead of the centre-left
(Socialist Party and allies) on 37.74%. So not exactly a night to remember for Hollande.

Le Pen's party was only running in 597 of the almost 37,000 municipalities up for grabs, and therefore won only 4.65% of votes nationwide. However, this is much better than in 2008 - when Front National only managed to run in 119 municipalities and won around 1% of votes nationwide in the first
round. This suggests it may be consolidating as an electoral force at the local level.

The second round of the mayoral elections will take place on Sunday 30 March. Interestingly, several top Socialist figures (from Hollande's spokeswoman Najat Vallaud-Belkacem to Prime Minister Jean-Marc Ayrault) have called for the centre-right to support a so-called Front Républicain - whereby the Socialists, the UMP and other centrist parties join forces to stop Front National candidates prevailing in the second round. However, UMP leader Jean-François Copé has this morning dismissed the idea.

So unlike Geert Wilders in the Netherlands, whose PVV party saw its support decrease slightly in last week's Dutch local elections, Front National is on a clear upward path - and it would be no surprise if it came out as the largest party in the upcoming European Parliament elections. It will be interesting to see how yesterday's results will influence the campaign. We have already noted that several centre-right French politicians - including Nicolas Sarkozy himself - have embraced, at least in rhetoric, a less idealistic approach to 'Europe'. Given the Front National's strong showing, this is only likely to continue.

Much has been written on this issue – see NYT, FT and Economist for background.

While there is anecdotal evidence in these articles about City links to Russia, they fail to delve deeper into the data and, importantly, lack any context as to what Russian business means to a city and financial services sector the size of London.

“Claims that the City of London would suffer major losses in case of financial sanctions against Russia are overblown. While it is true that there are some sizeable Russian investments in London, and it is home to a disproportionate number of Russian oligarchs, these are far from critical to a global financial centre such as London. The stock of Russian international investments in London is sizeable at £27bn, but it only accounts for 0.5% of total European international assets invested in London.”

“For all the talk of the large number of financial services provided to Russia, these only amount to 1% of total UK exports of financial services, business services and insurance. This would suggest that accusations that the UK Government is blocking tougher sanctions over fear of losses to the City don’t match the facts.”

“Sanctions related to financial or capital markets, for example severing access to credit for state-owned enterprises or Russian banks, might be an effective strategy to exert more pressure on Russia (given its reliance on external financing). Such move would be far more damaging to Russia than the City of London – though it may involve some losses for the latter. This should not, and does not seem to be, a big concern for the UK government. In any case, if things get to this stage, other EU countries may suffer far greater losses than the UK through wider economic sanctions hitting, for example, gas supplies and exports.”

There are plenty of factors to consider when looking at sanctions. While the City is one of them, in the scheme of the broader European links to Russia it does not seem huge (compared to some economies complete energy reliance). Furthermore, given the size of the City as a global financial centre the links to Russia seem to fall far short of the critical billing they seem to have been given.

Friday, March 21, 2014

Ukraine has now signed part of its Association Agreement with the EU, 3 out of 7 chapters - general principles, institutions and the somewhat controversial "political" chapter. The chapters on trade have been postponed (though the EU has unilaterally removed tariffs on Ukrainian goods).

The political chapter includes provisions on defence including promoting "gradual convergence in the area of foreign and security policy, including the Common Security and Defence Policy" the (CSDP). This raises two questions. Firstly, is the EU repeating the same mistake again? It's now accepted that it was a mistake to effectively try to force Ukraine to choose between Russia and the EU - an impossible choice for Kiev. As we argued in our recent briefing on this topic, the EU's "all or nothing" approach to its neighbourhood is no longer a suitable model for dealing with countries that don't have an immediate prospect of full EU membership. Both in terms of how it risks draw new dividing lines and create new geopolitical hotspots (the opposite to what EU enlargement has always aimed to achieve - and due to the very high barriers to EU membership existing as a result of decades of "ever closer union".

But by maintaining a clear security element in the AA at this sensitive time, isn't the EU effectively cementing Ukraine's Russia-or-west choice given that Russia won't want to accept anything that smells of security integration? Would it not have been better to sign the less threatening trade chapter first? Moreover, would it not have been better to wait a couple of months until after the Ukrainian elections and sign the AA with the new Ukrainian government, which would have an explicitly democratic mandate to do so?

EU diplomats say such fears might be over-stated given that the foreign policy/security chapter is actually quite mild in nature not committing anyone to anything else than dialogue, but is this how Moscow sees it?Secondly, could neutrality be a way to square Ukraine's European ambitions with its Russian dilemma? Austria has suggested that Ukraine could remain neutral, as indeed Austria sees itself, in order to calm relations with its large angry and increasingly isolated neighbour. But is this possible and how neutral is Austria in actual fact?

Is the EU a military alliance?

While NATO is obviously a military alliance, the EU does have its own defence policy; it sendstroops into conflict zones and runs missions such as Operation ATALANTA in Somalia and missions in Bosnia and Africa. It also has a mutual defence clause inserted via the Lisbon Treaty. Not all EU members, including Austria are in NATO but Austria has sent troops on EU missions. The EU and NATO are not synonymous but they do work closely together under the Berlin Plus Agreement, setting out terms of engagement. The difference between the two even for neutral states is now blurred.

So is it possible to "gradually converge" with the EU and remain neutral? Well in a technical sense yes. Ireland and Sweden will consider themselves neutral - or at least "non-aligned". But Ireland and even Sweden have committed troops to international missions. Norway has also sent troops on EU missions while remaining outside of the EU. If the current accession procedure is followed, it is therefore unlikely that Ukraine would join the EU and be able to remain outside of all EU defence agreements, unless special provisions would be made.﻿﻿﻿﻿

EU NATO can you spot the difference

Should this all worry Russia? Logically is should not because the EU, as we have seen with regards to Ukraine, is hardly a bellicose giant and poses no threat to Russia's Black Sea Fleet. But viewed from Russia's paranoid perspective, "ever closer union" might lead them to draw the wrong conclusions.

Again, a less integrated, less political and less over-reaching deal with Ukraine to carefully absorb it into Europe might be the most sensible option.

Thursday, March 20, 2014

We flagged up last week that the debate on EU migrants' access to benefits was kicking off in Denmark - potentially leading to a row with the European Commission.

New figures have been unveiled that will do little to assuage political tensions. According to the Danish Employment Ministry, government
spending on unemployment benefits to migrants from Eastern and Central
Europe has increased tenfold between 2008 and 2012 – from DKK
32 million to DKK 345 million.

The data prompted criticism from across the political spectrum - confirming that EU migrants' access to state welfare is very much a cross-party issue in Denmark.

We need to discuss what kind of protection we're able to offer in these cases. It's not a problem that will disappear.

Nadeem Farooq, the spokesman of the governing centre-left Social Liberal Party, warned:

The figure has risen quite dramatically, so we must take it seriously. We cherish freedom of movement, which makes Denmark wealthier. But we're also prepared to introduce controls and the necessary safeguards.

Interestingly, a proposal by the left-wing opposition Red–Green Alliance to make sure that EU citizens also pay Danish social insurance contributions in order to create "a level-playing field to qualify for unemployment benefits" is being supported by the anti-immigration Danish People's Party.

Meanwhile, the European Commission has announced that it will take legal action against Finland, which has a similar welfare system to Denmark and will therefore be backed by the Danish government in the legal challenge. The Commission has said it hasn't yet had time to look properly at how the Danish system currently works and what is being proposed (check out our previous blog for more detail), but informally it has said that the newly proposed measures look "illogical".

Wednesday, March 19, 2014

It's that time of year again. Chancellor George Osborne has delivered his latest budget. The EU geeks that we are, we have one question in mind: what does it say about the UK's contributions to the EU budget?

Well, as ever, this is complicated because there are lots of ways of measuring these contributions. The table below shows the main figures and how they compare to the OBR's previous estimates in December 2013 (click to enlarge):

It shows that the UK's total net and gross contributions to the EU budget are now expected to be around £2.3bn and £1.7bn higher over the next six years than previously forecast. However, the impact of this on the OBR's figures for the Government's Total Managed Expenditure (TME) and Public Sector Net Borrowing (PSNB) as shown in the Budget is neutral or even slightly positive over the same period, compared to the December forecast.

One of the reasons for this is that the OBR effectively treats the contributions that the UK makes to the EU via a share of VAT receipts, customs duties and sugar levies as a direct "EU tax" and the money therefore doesn't show up in the national accounts. UK contributions are also affected by the complex rebate calculations and how much the UK receives from the budget.

As the UK economy is now growing faster than others in the EU, the overall UK contribution increases. But because the rebate is calculated on the basis of the UK's VAT contributions and the UK gets a refund on some of the customs duties it collects, that will help reduce direct contributions from the UK Government's budget and balance out this figure over the six years.

Relative to GDP the increase is tiny and the good news is that it's due to a faster growing economy. Nevertheless, UK plc still ends up contributing more due to the growth in the 'EU's tax base'...

Ipsos Mori has this week published an interesting poll on public attitudes* in ten EU member states. Across the ten countries as a whole relatively few people want to leave the EU outright (18% on average), but the single most popular option is staying in the EU but reducing its powers (34%).

Just over a third want to see either the EU’s powers strengthened further (19%), or even a long-term policy of working towards a single European government (18%) - click to enlarge the charts.

Broken down by country, the British (68%), along with the Swedes and Dutch (69% and 68% respectively) are most in favour of leaving or reducing the EU’s powers:

The research suggests that, on average, two in three (68%) think things across the EU are moving in the wrong direction. People from the Netherlands, Sweden, Belgium and Britain are in line with the average, but those in the Mediterranean countries are the most pessimistic.

France, is the most pessimistic of the countries polled, whch seems to have a lot to do with the state of the country's economy. People in France, Italy and Spain are all particularly negative about the EU’s impact on the economy (74%, 74%, and 68% respectively are critical), and many feel that their economy has been damaged by the demands of austerity (75%, 70%, and 75% respectively).

The UK political debate on Europe may be a few years ahead of many other countries (perhaps with the exception of the Netherlands), but at the level of the individual, there are many people disenchanted with the European project. Many countries are deeply split but, on average, there is clearly an appetitie for the EU to do less. Most interesting though is the striking fault line in the eurozone. Francois Hollande has had precious little influence on EU policy since his election as president, but the question is, how long before the French public's disenchantment is reperesented by its politicians?

If you think the UK is the awkward partner, imagine if French politicians actually started telling Chancellor Merkel what their people think about Europe.

* It should be noted that the poll is not representative of the entire electorate in Belgium, France, Great Britain, Germany, Hungary, Italy, Poland, Spain and Sweden (where 16-64 year olds were interviewed), while the Dutch panel is representative of voters. Why they chose not to poll people over 65 is unclear and in our view is likely to skew the results somewhat (in different directions for different countries).

Tuesday, March 18, 2014

Following a speech to both Houses of the Russian Parliament this morning, Vladimir Putin has signed a Treaty that will see Crimea and City of Sevastopol joining the Russian Federation. Western leaders have warned the move would have “additional and far-reaching consequences”, on top of the targeted sanctions agreed by EU foreign ministers on 21 Russian and Ukrainian individuals yesterday.

What could these additional measures involve? And how far can the EU go? We have just published a new briefing addressing these questions. We have looked at what tools the EU has available to force Russia to back down in Crimea, including the effectiveness of the various sanctions it could deploy.

Our assessment is that, in the short term, the most effective economic measures could be a combination of targeted sanctions on individuals and business interests and potentially limiting sales to Russia of products on which they are externally reliant – such as machinery, chemicals and medical products. While Moscow can employ rogue tactics in the short-term which Europe can’t match, in any prolonged economic stand-off, the odds are in the EU’s favour.

Additional targeted individual sanctions or a potential arms embargo, would be hard to agree amongst the EU’s 28 member states and their impact remains unclear, though there may be some scope for a group of EU states to move ahead with some additional sanctions if it’s not possible to get agreement at the level of all 28.

Still, cleverly targeted sanctions on individuals and business interests could hurt Russia. Between 2008 and 2013, $421bn worth of private sector money – equivalent to 20% of Russian GDP – has flown out of the country, while Russia’s Net International Investment Position (NIIP) remains strongly positive. This suggests that there are sizeable amounts of Russian money invested abroad on which sanctions could be imposed, causing significant problems for high-ranking individuals and businesses. That said, the routing of this money through offshore centres makes it very difficult to track (click on the graphs to enlarge).

Therefore, the most effective economic measures could be a combination of targeted sanctions on influential individuals close to the top of the regime, business interests, specific firms wielding power in Ukraine (such as Gazprom) and potentially limiting sales to Russia of products on which they are externally reliant – such as machinery, chemicals and medical products (click on the graphs to enlarge).

Sweeping energy sanctions would hit Russia the hardest but due to the EU’s dependence on Russian gas – in some countries as much as 100% of gas imports are Russian – this option is politically unlikely and could prove prohibitively expensive for the EU.

Such decisions should not be taken lightly and Russia has an array of retaliatory options, including leveraging energy market power to secure favourable bilateral deals with other countries, applying tit-for-tat sanctions or, in extremis, wielding its hard power.

However, whilst Moscow can use such rogue tactics in the short-term, which the EU, for various reasons can’t, in any prolonged stand-off the odds favour the EU, due to Russia’s disastrous demographic trends and relatively undiversified economy. For all these reasons, a negotiated settlement still remains the most likely option.

Fundamentally, while this is a conflict driven by Moscow, it illustrates the EU’s “all or nothing” approach to its neighbourhood is no longer viable in the 21st Century. If the EU is to extend its influence further, it must be prepared to offer an alternative model of enlargement or association, lowering the political hurdles on the path to Europe.

Follow us on Twitter @OpenEurope for all the latest updates on the Ukraine crisis.

The Ukrainian crisis has shown up the short-term limitations of the EU's 'soft power' in the face of a determined Russian regime not afraid of wielding its 'hard power'. Though we would argue that in the long-term, the odds still favour the EU due to Russia's disastrous demographic trends and relatively undiversified economy - and there are things the EU can do without resorting to Kremlin tactics - it's not a secret that Vladimir Putin responds better to the stick than the carrot.

Put differently, Putin doesn't exactly run for cover when Jose Manuel Barroso and Herman Van Rompuy put out a joint statement. As this stand-off is now about hard economic and political power, enter London.

As Defence Secretary Philip Hammond announced in the Commons yesterday:

"I am able to advise the House this afternoon that we have taken the decision this morning to offer NATO UK Typhoon aircraft from late April to augment the Polish contribution to the NATO Baltic air policing mission. I hope that will provide reassurance to our NATO allies in the east."

The UK is therefore the first and so far only NATO or EU member to commit troops to strengthening the EU-Russian border. TVNcites the Estonian PM Andrus Ansip describing the UK's decision as "an important step" while Foreign Minister Urmas Reinsalu noted that it constitutes a "clear and unambiguous" response to Estonia's desire to strengthen NATO's presence in the Baltic.

However, other politicians who have been been very hawkish over Ukraine - but also the most vocal critics of David Cameron in Europe more broadly - have been quiet by their usual standards. We don't want to name names, but yes, Radoslaw Sikorski and Carl Bildt we're looking at you. (Although to be fair, while they have not commenting on the jet deployment specifically, both of them have praised the UK's stance on Ukraine more generally).
This is significant because some - not least Sikorski himself - have warned that if Russia is not stopped in the Crimea, the Baltic states which have significant Russian minorities could be next on Putin's hit list. It's easy to whine about the UK being Europe's grumpy, old man complaining in the corner. However, when it comes to dealing with thugs, all of a sudden, London becomes strangely popular.

This again goes to show that without the UK, the EU's geopolitical credibility would be sorely diminished. Perhaps one for certain foreign ministers to keep in mind when the waters are calmer.

Monday, March 17, 2014

Writing in the Sunday Telegraph, David Cameron set out seven objectives - or eight if you read between the lines - for a Conservative EU﻿﻿﻿﻿ reform agenda ahead of that potential 2017 EU referendum.
Surprisingly, despite this being the most explicit that David Cameron has been in setting out a 'shopping list' (an unfortunate term), it has generated surprisingly little attention, in the UK and abroad.

To be fair, none of these objectives are completely new, one is not strictly to do with the EU, while in the case of some of the others it would be rather difficult to define success. Interestingly only the point about removing the commitment to “ever closer union” would definitely require treaty change.

In large parts, these are broad principles rather than specific policies - which is wholly appropriate given that it would be silly to set out a set of clear polices so far in advance (though some of these could easily get under way now). Here are the seven:

Commitment

What does it involve?

Treaty Change?

“Powers flowing away from Brussels, not always to it”

This is an overarching principle which would take a number of forms, including repatriating entire areas of EU powers, such as regional policy, to repealing specific regulations, to structural changes in the EU (incl. possible Treaty changes) that makes it easier to roll back the acquis such as a "green card" for national parliaments.

Depends. Reforms to regional policy and repealing individual rules, such as the Working Time Directive, would not require treaty change. Removing entire EU powers or structural changes might.

“National parliaments able to work together to block unwanted European legislation.”

At present a third or more of national parliaments can require the European Commission to reconsider proposals (a yellow card) - but it has only been used twice. There are various proposed ways of strengthening this mechanism to allow national parliaments collectively the power to strike down EU laws. This could give them a legal veto – the ‘red card’ or simply strengthen the existing mechanism.

If placed into EU law it would require treaty change. However, the Dutch Foreign Minister has suggested this could also be done through a "political agreement" between the Member States requiring the Commission to treat the yellow card as a de facto veto.

“Businesses liberated from red tape and benefiting from the strength of the EU’s own market – the biggest and wealthiest on the planet – to open up greater free trade with North America and Asia.”

De-regulation is very difficult to quantify. It could involve proposals to exempt small business from EU regulations. It could also involve imposing a repeal mechanism (a green card operated by national parliaments), sunset clauses, for EU laws as well as reviewing old EU regulations.

This agenda also suggests further services liberalisation and the completion of the Trans-Atlantic Trade and Investment Partnership (TTIP) and further free trade agreements.

None of the "competitiveness agenda" requires Treaty Change.

However, it is far from certain that TTIP will be agreed and then ratified while cutting EU red tape is always a challenge in the face of interest groups and the European Parliament - but far from impossible in the face of political will.

“Our police forces and justice systems able to protect British citizens, unencumbered by unnecessary interference from the European institutions, including the ECHR.”

This could involve withdrawal from the ECHR, successful reform of the ECHR or a UK Bill of Rights limiting its impact in the UK.

The reference to “European Institutions” could imply removing the European Court of Justice’s (ECJ) jurisdiction over EU crime and policing law.

Withdrawing from the ECHR would not require EU treaty change as it's not to do with the EU.

Removing ECJ jurisdiction over EU crime and policing laws would.

“Free movement to take up work, not free benefits.”

This could involve a number of changes to EU rules around free movement including strengthening the link between economic contribution of EU migrants and access to benefits and ending "exportability" of child benefits.

Reforming the Free Movement Directive and the Social Security Regulation could be done without treaty change. Putting an outright cap on EU migration - which Cameron has NOT suggested - would require Treaty change.

"Support for the continued enlargement of the EU to new members but with new mechanisms in place to prevent vast migrations across the Continent.”

This would involve imposing tougher transitional controls on all future EU accessions, for example by extending the existing 7 year maximum transitional period or linking the right to free movement to population size and/or relative wealth levels.

EU enlargement requires a new Treaty with the accession state(s) over which all existing EU members would have a veto, so London could push this demand as the price for its agreement. However, enlargement does not alter the underlying EU Treaties themselves.

Dealing properly with the concept of “ever closer union”.

The EU treaties currently include a commitment to “ever closer union”. Removing these words would be largely symbolic but could have some political, and possible indirect judicial, impact.

Yes, given that the concept is itself enshrined in the treaty.

In addition, though he has not said so specifically, apart from a passing reference to need to achieve a union for both eurozone and non-eurozone countries, another priority for David Cameron will most definitely be to secure safeguards against eurozone caucasing.

A number of questions still remain of course, including the various reform ideas not touched on this article, including the EU budget, employment law or dealing with the ECJ (though they all could fit under the general principles he has laid out).

Lastly, David Cameron has said he will pursue this reform agenda followed by a referendum “if he is Prime Minister”. This is important as he appears to be setting down a red-line in any future negotiations with the Liberal Democrats to continue the Coalition.

The big question is if these reforms were to fail, would he campaign to leave or stay in regardless?

Over on Conservative Home Open Europe's Christopher Howarth wrote the following article:

Firstly, a disclaimer: Russia is 100 per cent responsible
for its invasion of the Crimea, just as Germany a hundred years ago was for
responsible for invading Belgium. Nothing dilutes these facts. However, just as
historians disagree as to whether the First World War could have been avoided,
it is legitimate to look at whether a better handling of the Ukraine crisis by
the “West” generally – and the EU specifically – could have led to a different
conclusion.

We need to understand what Russia wants. It has two aims –
safeguarding its Black Sea Fleet base in Sevastopol (for emotional as well as
strategic reasons) and maintaining a friendly compliant government in Ukraine
willing to keep the border open to Russian trade and people. Under both
Timoshenko and Yanukovych, this is exactly what Russia had.

So what has caused the current crisis? Russia’s naval base
is on a lease, so for now it is protected, but Russia fears that a pro-western
Ukrainian Government, joining NATO and the EU, could jeopardise its operation.
These fears maybe overdone, but a more potentially serious threat comes to
Russia’s trade in the form of Ukraine’s potential EU membership.

The EU is a customs union, which means that its external
trade is decided collectively around an external customs wall – the crucial
difference between it and a Free Trade area. But as well as being a customs
union, the EU has become a political construction with a defence element
including a mutual defence guarantee mirroring that of NATO – inserted via the
Lisbon Treaty. So from a Russian point of view the EU no longer an economic
club, but more a political and defence power block synonymous with NATO.
Indeed, Russia is so impressed by the EU as a power block it has sought to
imitate it in its own Eurasian Customs Union – which it had hoped Ukraine would
join.

EU and candidates and Eurasia and its candidates

Looked at from the inside, the EU eliminates borders,
creating an area free of customs, visas and – within Schengen – all border
controls. This however comes at a price, and the price is often paid by the
EU’s neighbours. We have seen this before in Moldova. Prior to Romanian EU
accession, Moldovans could freely travel to Romania but after Romania joined
this came to an end – Moldova was on the wrong side of the EU’s external
frontier. Unsurprisingly, Russia would not wish for the same on its border with
Ukraine.

Ukraine is therefore caught between two opposing power
blocks. For many years, Ukraine managed to balance the competing interests and
different aspirations of both its Russian and Ukrainian speakers. From Moscow’s
point of view, it was working: Ukraine had leaders who accepted Russian largess
in exchange for influence, renewed their lease on Sevastopol, kept trade moving
and allowed Russians and Ukrainians to travel visa free – something that
Ukrainian EU membership could put in danger.

It should therefore have been possible to predict that
Russia would react badly to further moves by Ukraine towards the EU. Despite
this, no effort seems to have been made either to dampen Russian influence by
shoring up Ukraine’s finances, thus enabling them to make the jump, or
alternatively to mollify and reassure Russia. We were left to watch as an EU
deal with no immediate cash offering was outbid by hard Russian cash with a
bankrupt Ukrainian President taking his country swerving to the east. The
reaction in western Ukraine was predictable, as was the Russian reaction when
protesters hostile to the Russia seemed to take control.

Even at that point, not all was lost for Russia. Ruslan
Pukov, a graduate of the Russian Ministry of Foreign Affairs, points out in the New York Times that Tymoshenko was originally
Russia’s favoured candidate, that her re-election in an early poll would for
Russia have been a reasonable outcome – and for that pro-Russian electors from
Crimea within a united Ukraine would help. Speeding up the signing of the EU’s
Ukrainian Association Agreement and the pronouncements of some EU foreign
ministers about Ukraine’s EU membership potential (however genuine or not)
have, however, fanned the fears of those in Russia who feel that Ukraine is on
route to being “lost” into an opposing and not necessarily friendly power
block. Russia’s preferred option would be a pro-Russian Ukraine. If Russia
annexes Crimea, it may look like a Russian victory but in reality would be an
admittance of a wider failure.

It is for Ukraine to decide whether it should join the EU.
If that is their settled wish, we should not shut the door just to appease
Russian sensibilities. Nor should we confuse justifiable anger at corruption
(often linked to Russia) with a genuine love of EU integration shared by all
Ukrainians. For now, we should help Ukraine improve its standard of government,
help it strengthen its economic independence (one way could be through shale gas development) and do what
we can, through sanctions, to dissuade Russian aggression. But we should be
aware that the makeup of the EU, the nature of its integration and enlargement,
combined with ‘all or nothing’ decisions being forced on the Ukraine by both
the EU and Russia, have polarised Ukrainian politics and are having
consequences.

In the longer term, it is time for the EU to rethink how it
deals with its neighbouring states. Those that have chosen not to join the EU
or border the EU but will never join deserve better than the imposition of a
hard frontier dividing them from historic partners. If the price of EU
integration within is division without, someone will pay the price. If the EU
was not so rigid, did not require conformity with everything and offered a
genuine partnership status that could work for Ukraine without antagonising its
other neighbours, it might be a form of membership that others could take up –
including, someday, even Russia.